Zale: The Perpetual Red Ink Machine Finally Runs Black

by Kyle Woodley | August 28, 2013 9:51 am

When is a loss not a loss?

When it’s a gain.

The silly riddle is just a way of explaining away how mall jewelry retailer giant Zale (ZLC[1]) — parent of Zales, Gordon’s, Peoples and other retailers — is about to tack on another 20% gain to its 2013 doubling after reporting a loss of 25 cents for the fiscal fourth quarter.

Source: S&P Capital IQ MarketScope

That’s because that 25-cent loss was not only better than the analyst community’s expectations for a 33-cent loss and a leap over last year’s 61-cent loss … but it was just enough to push Zale over the hump to a 2-cent profit for 2013, marking its first full-year profit since 2008.

Zale’s 2-cent victory for the full year marks a stark turnaround from 2009, when the company lost nearly $6 per share. This also marks the first time in years that ZLC has posted a profit in any other quarter than its fiscal Q2, which runs during much of the holiday shopping season. And all four quarters of 2013 came in better than the year-ago period.

The real feat for Zale has been on the margins front — while earnings have improved markedly all year long, it hasn’t come on much of a bump from the revenue front. Q4 revenues of $417 million were only 2.5% better than the year-ago period — the highest uptick in sales for any of ZLC’s quarters this year. For the full year, operating margins improved 90 basis points to 1.9%, and gross margins were 60 basis points better at 52.1%.

When Citigroup initiated Zale last year at a “buy” rating, it noted many of the same drivers being credited for ZLC’s improvement this year, including “improved product execution and portfolio, a fixed capital structure, and better store initiatives.”

Looking forward, this diamond might continue to shine. Analysts see ZLC earning 40 cents for fiscal 2014, though it should be noted that Zale’s 2013 performance actually came well under expectations for a full-year profit of 17 cents.

Two things to watch out for, though: a worn-out American consumer, and a frothy valuation.

ZLC’s outstanding performance has been more exception and less rule, at least in the retail sector, which has sported an ugly earnings season for the most part. Then again, investors could take heart in continued strength in jewelry and luxury names such as Tiffany (TIF[2]), Michael Kors (KORS[3]) and Movado (MOV[4]), which all impressed at the earnings confessional.

And on the valuation front, ZLC now sports a price-to-earnings ratio somewhere in the 500s thanks to its 160% year-to-date run.

But after going years without having an “E” in “P/E,” a bloated number like that can be considered an improvement.

Kyle Woodley[5] is the Deputy Managing Editor of InvestorPlace.com[6]. As of this writing, he did not hold a position in any of the aforementioned securities. Follow him on Twitter at @IPKyleWoodley[7].